The Exchange

How Washington Could Push Gas Prices Higher

The Exchange

No politician would run for office by calling for higher gasoline prices. Yet policymakers in Washington may be on the verge of causing some pain at the pump for consumers.

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Most Americans don’t realize that, when they gas up their car, up to 10% of what goes into the tank is ethanol distilled from corn. Congress required refiners to blend ethanol into gasoline in laws passed in 2005 and 2007, which were intended to spur the production of renewable fuels and reduce U.S. dependence on foreign oil.

But driving habits, automotive technology and the overall economy have changed in ways nobody anticipated back then, making federal ethanol targets harder to meet without disruptive changes that could cost drivers more. Fixing the problem requires bipartisan Congressional action, the very thing that seems most scarce in Washington these days.

“There are benefits to ethanol,” says Avery Ash, manager of regulatory affairs at AAA, the driving club. “But motorists need to make an informed decision that doesn’t put them or their vehicles in danger."

Under the 2005 and 2007 laws, refiners must add an increasing amount of ethanol to gasoline every year until 2015, when the overall ethanol target is scheduled to hit 15 billion gallons per year and stay there. When legislators wrote the law, they assumed gas consumption in the United States would continue to grow at the same pace as during the prior decade. So the ethanol target could grow, too, without a big jump in the proportion of ethanol in gasoline.

A failure to anticipate

What they failed to anticipate was a grueling recession that cut into gas purchases, along with more efficient cars that simply require less gas. If the ethanol targets were defined as a percentage of the fuel supply — say, 10% — there wouldn’t be a problem. But since the targets are set in gallons, adding more ethanol to a shrinking pool of gasoline can push the ethanol content beyond a level that automakers say is safe in cars. Hitting this “blend wall” has now created a fresh standoff between supporters and opponents of ethanol, which is controversial to start with.

The Environmental Protection Agency, which administers the ethanol rules, recently provided some temporary relief by scaling back the 2013 ethanol target and signaling new flexibility on the 2014 target, which hasn’t been set yet. But it’s not clear the EPA can legally change the target on its own, without Congressional approval. Some in Congress recognize the need to revise the law, but the possibility of changing the ethanol mandate has already set in motion the fierce lobbying, by parties on both sides of the issue, that often generates gridlock in Washington and makes inaction the path of least resistance.

The whole matter affects drivers because the ethanol mandate has been raising costs for gasoline refiners, which pass increases on to consumers whenever they can. Refiners that don’t meet the ethanol targets can still comply with the law by purchasing credits from other companies that earn them from the government by producing or selling ethanol. That’s normally a routine business decision. But the price of those credits, which are traded like stocks or commodities, has soared this year, and while they fell back after the EPA lowered the 2013 target, they’re still about 10 times higher than they were at the start of the year.

Gas prices this year have risen by about 25 cents per gallon, to an average of $3.55 or so. There has, however, been a bit of relief over the past two weeks, as U.S. gas prices have dropped by around 8 cents. It can be hard to isolate what pushes gas prices up or down, but Roger Read of Wells Fargo Securities wrote in a recent report that ethanol credits “have clearly contributed to higher retail fuel prices in 2013.” Gas prices could go higher if Congress fails to act on the ethanol mandate and leaves the EPA to sort out the matter with limited authority. One option refiners have is to export more gasoline refined in the United States if rules here — or mere uncertainty about what the rules will be — raise their costs. A drop in the supply of gas would be another thing that could push pump prices higher.

If Congress does reopen the ethanol mandate, consumers won’t necessarily benefit, either. Ethanol boosters would like a new government standard pushing the maximum ethanol content in motor fuel from 10% to 15%. But several automakers, mostly those based in Japan and Europe, say the higher concentration of ethanol could damage engines and void warranties.

Less bang for the buck

Ethanol also provides less bang for the buck, since it has a lower energy content than gasoline and therefore generates lower fuel economy. Ethanol usually costs less than gasoline, but AAA estimates that, when adjusted for MPG, ethanol actually costs 15 to 20 cents more per gallon in total fueling costs. So more ethanol in gasoline would lower gas mileage slightly, pushing overall fueling costs up a bit.

The oil industry would love to see the entire mandate scrapped, with some analysts arguing that ethanol is an inferior fuel that’s no longer necessary, given the recent surge in domestic oil production. Some critics also argue that the use of corn for fuel makes less available for food, pushing food prices up. Yet corn states such as Iowa — site of the first presidential nominating context during each election cycle — still wield enough political power in Washington to sustain support for a key, home-grown industry.

[See related: Cheap Corn Means Fat Wallets for Consumers]

Drivers, meanwhile, are usually hypersensitive to gas prices, yet the arcane and confusing details of the ethanol mandate seem to have largely escaped their notice, according to polls by AAA and others. If other factors push gas prices down, drivers will probably enjoy the break on their wallets with a cheerful lack of interest in the technicalities of ethanol policy. If gas prices go much higher, on the other hand, politicians may have to answer for it.

For once, they can.

Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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